The Center's work on 'Process' Issues

A More Realistic Look at Sequestration

June 14, 2012 at 2:04 pm

In a recent release, the Bipartisan Policy Center (BPC) estimates that the automatic cuts (“sequestration”) in defense funding scheduled for next January could shrink that funding by 14.7 percent in 2013.  That figure, however, is based on several very questionable assumptions that essentially amount to a worst-case scenario.

We agree with BPC on the dollar size of the scheduled defense cut:  almost $55 billion.  But, based on the law and what we regard as more reasonable assumptions, our estimate of the percentage cut is much smaller than BPC’s:  9.5 percent.  (Both percentage figures assume that the President exercises his discretion to exempt military personnel funding from cuts; without this exemption, we estimate a 7.5 percent defense cut.)

BPC’s percentage figure is much larger than ours in part because BPC essentially assumes that, even with sequestration looming in January, the Defense Department and other federal agencies will proceed full-speed-ahead in the first quarter by committing one-quarter of their total annual funding in those months.  If they do that, they’ll have to squeeze the entire $55 billion funding cut into the remaining three-fourths of the fiscal year.

We think that’s quite unlikely.  Agencies know sequestration is scheduled, and they know it would be much more prudent for them to obligate funds at a slower rate during October-December in order to spread the cuts over the entire fiscal year.

Even more questionable, BPC assumes that Congress will enact legislation to alter the Budget Control Act (BCA) by protecting war funding in a way that forces even bigger cuts in the rest of the defense budget — namely, by exempting war funding from sequestration.  Based on this assumption, BPC removes war funding from the base that it uses to calculate the percentage cut under sequestration.  If Congress exempts war funding, sequestration will need to take a bigger bite out of the rest of the defense budget to produce the required $55 billion in defense savings.

But for that to occur, Congress would have to change the sequestration rules in the BCA.  And if gridlock leads to sequestration actually taking effect, then it’s quite unlikely that Congress would have succeeded in passing legislation to do that.  Moreover, as our analysis of sequestration explains, if Congress wants to protect war funding, it can readily do so in a way that does not require making deeper cuts elsewhere in defense and does not require amending the Budget Control Act.  Congress can simply raise war funding this fall above the President’s proposed level by enough to offset the cut in war funding that will occur under sequestration, so that the post-sequestration level of war funding ends up at the President’s requested level.  This effectively shields war funding without increasing the percentage cut that sequestration causes in the rest of the defense budget.

Congress has this option because the Budget Control Act’s funding caps do not apply to war funding.  We think Congress is more likely to take this option than to enact legislation exempting war funding from sequestration and thereby making the rest of defense take a bigger hit.

To be sure, cutting $55 billion from defense programs will hurt.  So will the required $16 billion cut in certain entitlement programs such as Medicare.  And so will the required $39 billion cut in non-defense discretionary programs — an area of the budget already hit in the past few years — which would constitute an 8.4 percent reduction in affected programs.  A balanced deficit-reduction package would be far superior to sequestration, which is not a sound way to govern.

But, when it comes to sequestration, we should take a realistic look at what it means, not one based on worst-case scenarios that won’t likely come to pass.

Yes, We Can Avoid Both a Recession and a Long-Term Debt Explosion

June 7, 2012 at 3:09 pm

As my latest post for US News & World Report explains:

[T]he headlines generated by two recent Congressional Budget Office (CBO) reports could lead policymakers to think they are in a damned-if-you-do-damned-if-you-don’t dilemma over their budget choices — reducing the deficit risks a recession; not reducing it leads to a dangerous and unprecedented debt explosion.  But a closer read of the CBO reports says that if lawmakers have the will, they can find the way to avoid both.

One CBO report says that if we let all the scheduled tax and spending changes take effect in January, the resulting large reduction in the deficit would likely throw the economy into a recession in 2013.  Our recent analysis cautioned that while the economy would “start down a slope that could ultimately lead to a recession in 2013 . . .  that’s a far cry from the economy falling off a cliff and plunging immediately into recession.”  Lawmakers would have a little time to put better policies in place.

The other CBO report estimates that, without a politically sustainable deal to reduce long-term deficits, federal debt held by the public could rise to twice the size of the economy by 2037.  (That’s the yellow “Extended Alternative Fiscal Scenario” in the CBO graph below.)  So it would be a serious mistake to simply prevent January’s tax and spending changes from taking effect.

Source:  Congressional Budget Office

So, what’s the solution?  The first CBO report points out that lawmakers can “minimize the short-run costs of narrowing the deficit very quickly while also minimizing the longer-run costs of allowing large deficits to persist.”   Our paper sketches the beginnings of how they might do that:

[A] cost-effective way to continue using the tax cuts to shore up the weak economy would be to extend the middle-class tax cuts for a year or two, allow the upper-income tax cuts to expire, and extend the tax-credit expansions targeted on low- and moderate-income households.  Such an approach would provide the most “bang-for-the-buck” in terms of supporting the economic recovery in 2013-14 without seriously compromising long-term fiscal sustainability.

How Much Would Raising the Bush Tax Cut Threshold Cost?

June 5, 2012 at 10:00 am

As we reported last week, the Joint Committee on Taxation (JCT) calculates that letting President Bush’s income tax cuts expire for families making over $1 million would save only 56 percent as much revenue as President Obama’s proposal to let the tax cuts expire for families making over $250,000.

It has also been noted, though, that 81 percent of the benefits of the Bush tax cuts for families making over $250,000 goes to millionaires.  If 81 percent of these high-income tax cuts goes to millionaires, why does setting the threshold at $1 million raise only 56 percent as much as setting it at $250,000?

The difference between the 81 percent and 56 percent figures represents the tax cuts that millionaires now receive on their income between $250,000 and $1 million.  Under the Obama proposal, they wouldn’t get to keep these tax cuts because the tax cuts would no longer be applied to income above $250,000.  But they would get to keep those tax cuts if the Obama proposal is changed so that the threshold is $1 million.

That’s why raising the threshold to $1 million would be so costly — losing $366 billion over 2013-2022, JCT estimates.

Consider a married couple earning exactly $1 million in salary (and taking the standard deduction).  If policymakers extend the Bush marginal tax rates for families up to $1 million, that couple would get roughly $31,000 more in tax cuts than if policymakers extend the Bush rates “only” for families up to $250,000.  This is because they would face the Bush marginal income tax rates (33 and 35 percent) instead of President Obama’s proposed rates of 36 and 39.6 percent on part of their taxable income.

Taxpayers with incomes between $250,000 and $1 million would gain much less from raising the threshold to $1 million.  A couple earning $300,000 and taking the standard deduction, for example, would get about $1,200 more in tax cuts than under the $250,000 threshold because part of their income would be taxed at 33 percent instead of 36 percent.  (Their income isn’t high enough to benefit from the cut to the top tax rate.)  That $1,200 is only about 4 percent the size (in dollar terms) of the increase in the millionaire couple’s tax cut.

Citizens for Tax Justice estimates that fully 50 percent of the tax cuts in 2013 from moving the threshold from $250,000 to $1 million would go to taxpayers with incomes above $1 million.

Understanding the “Fiscal Cliff”

June 4, 2012 at 4:39 pm

We released a new analysis earlier today that sorts through some of the fears about what policymakers and pundits are calling the “fiscal cliff”:  the income and payroll tax cuts that will expire and the across-the-board spending cuts that will take effect — all around New Year’s Day.  Here’s the opening:

The sooner policymakers enact legislation to put the budget on a sustainable long-term path without threatening the vulnerable economic recovery, the better.  But, as they prepare for an almost certain post-election “lame duck” session of Congress, policymakers should not make budget decisions with long-term consequences based on an erroneous belief:  that the economy will immediately plunge into a recession early next year if the tax and spending changes required under current law actually take effect on January 2 because policymakers haven’t yet worked out a budget agreement.

Click here to read the full paper.

On Revenue Losses from Extending Bush Tax Cuts up to $1 Million: That’s JCT’s Projection, Not Ours

May 31, 2012 at 5:29 pm

We issued a paper yesterday in which we noted that extending President Bush’s income tax cuts for households making up to $1 million a year is projected to lose nearly half of the revenue that President Obama’s proposal to extend the tax cuts only for households making up to $250,000 would raise.

Some news reports, such as this one, have mistakenly suggested that the projection we cited of the lost revenue from this proposal compared to Obama’s — a loss of $366 billion over the coming decade, or 44 percent — is a Center on Budget projection. In fact, the estimate comes from the Joint Committee on Taxation (JCT), which is Congress’ official scorekeeper on tax legislation.  It is JCT’s estimate of the revenue loss of extending the Bush tax cuts on the first $1 million of a tax filer’s income — and ending the tax cuts on income above that — rather than of extending the tax cuts only on the first $250,000 of income as Obama has proposed.